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Gulf between U.K.'s PRA and insurance industry over Solvency II – but there could be less paperwork

By Selwyn Parker

Published
January 11, 2018

The shadow of Brexit
looms large over U.K.’s giant insurance industry as it continues to labour with
the complexities – some of them unnecessary, according to critics -- of the
massive exercise known as Solvency II.

As the powerful
Treasury Committee points out in a revealing report in September 2017 on the
implementation of Solvency II, which is very much an EU initiative, there is too
wide a difference between the Prudential Regulation Authority and the insurance
industry on some of its most fundamental elements. A particular bugbear for
firms is the much bigger reporting requirements dumped on them.

In what is very much a Brexit-linked issue, the committee has made a
strong plea for the industry and the PRA to figure out between them exactly what
parts of Solvency II can be changed right now while the UK remains a member of
the E.U. That is, without first seeking the approval of Brussels.

And, just as importantly, the committee want to know how Solvency II
should be redesigned for the benefit of British firms after U.K. finally walks
away from Brussels, whenever that may be.

To complicate
things further, there is an ongoing review of Solvency II on the other side of
the Channel even though the directive has only been in operation since 2016.
Launched by the European Insurance and Occupational Pensions Authority (EIOPA),
this review is a highly technical one about infrastructure investment risk
categories and is of interest to specialist insurers. But EIOPA is also working
on formulae for capital requirements, reporting of measures of long-term
guarantees and of equity risks among other issues that are unlikely to simplify
the way Solvency II is applied in the real world.

Pivotal

Although the banking industry hogs most
of the headlines, Britain’s insurance industry is of pivotal importance to the
economy. In 2016 it managed over £1.9 trillion in investments, paid nearly £12bn
in taxes, and has a gross value added (a useful measure of its contribution to
the economy) of £35bn a year. And then of course there’s the London Market,
which includes Lloyds of London and insures global risks through 84 syndicates
that perform a worldwide role centred in the City.

Insurance companies perform a fundamental social service – one large
firm estimates its pays out more than £40m a day in various claims. And the
industry does all this with remarkably little fuss. In the last 40 years, there
have been only two significant failures – Equitable Life whose guaranteed
annuity products fell foul of hostile interest rates in the 1990s and
Independent Insurance Company which went bankrupt in 2001, a victim of
fraudulent activity at senior level.

The cost of managing
these failures was modest compared to those in Britain’s banking sector that
cost the taxpayer dearly.

Unlike the post-financial crisis
regulations introduced to prevent banks from collapsing without causing
long-term economic damage, the Solvency II directive was not therefore designed
as a response to failures by British insurance firms. Quite the contrary, given
the industry’s history of responsible self-management.

Yet
Solvency II has been something of a monster to develop and implement. It took 15
years from its conception to put into practice, an indefensibly long time. In
fact, the former chief executive of the PRA, Andrew Bailey, famously said that
“the history of the EU process on Solvency II is shocking.”

According to studies by Treasury, the cost to UK business of
implementing the directive is about £196m a year. And that’s on top of a one-off
cost of £2.6bn.

Usefulness

Even
now, after nearly two years in operation, there’s a divergence of opinion about
the usefulness of Solvency II. While some -- regulators in particular -- see it
as the pre-eminent system that firms must by default implement in their own
interests even if they are not located within the EU, others see it as a
typically Brussels-designed product that has adopted a rigid, rules-based rather
than a principles- based approach in the ultimate aim of ensuring the stability
of the sector.

The technical term for this kind of directive
is “maximum harmonization” – that is, a regulation that is enforced equally
across the 28 member states. The ability of national regulators to fine-tune it
for local markets has been deliberately designed out.

And
it’s in the narrow rules-based principle where tension has arisen between the
British industry and the PRA. To put it simply, there are important technical
areas where the PRA seems to prefer to stick to the letter of the law while the
industry would prefer some more latitude.

Reporting
burden

Of direct interest to the compliance function, one
of the most burdensome requirements of Solvency II is the amount of reports that
firms must hand to the regulator. Many respondents to the Treasury Committee
hearings complained that the PRA has added a whole raft of U.K.-specific
reporting obligations on top of the already immensely detailed, obligatory
annual and quarterly returns required by the original directive. In short,
gold-plated reporting.

The committee’s report is sceptical
about this – “it is unclear what value much of the reporting adds.”

Lloyds of London, one of the most influential respondents, appears to
agree. In its submission it wondered: “Solvency II’s requirements are very
detailed and it is not clear what use supervisors can make of all the
information they receive.”

Putting it purely in terms of
volume of paper, the Association of British Insurers estimates the volume of
obligatory reporting has increased by four to eight times compared with the
former ICAS regulations.

The PRA is not giving up much
ground though. The regulator’s head, Sam Woods, argues that all this extra data
will come in useful if there’s a future crisis of some sort and the PRA must act
quickly. Better to have vital intelligence in hand rather than to go looking
for it in a hurry. As a small concession, the PRA has however agreed a
dispensation for smaller firms that, it estimates, will remove about 70 per
cent of their quarterly reporting burden.

After
Brexit

After investing so much time and money in Solvency
II, nobody in the insurance industry appears to want to dump it. The looming
issue now – and it’s one the Treasury Committee wants dealt with – is how the
PRA should interpret Solvency II for the post-Brexit era in a way that
reinforces the standing of Britain’s insurance industry on a global rather than
just an E.U. basis.

Without going into all the
technicalities such as proportionality and internal models, the gulf between the
PRA and the industry appears to come down to the degree to which the rules-based
philosophy of Solvency II conflicts with the judgement-based approach, which so
many seem to prefer. This is because it allows national regulators a degree of
interpretation in response to what the real-world throws at their country’s
firms.

With an industry that’s worth about £35bn a year to
Britain, this is clearly worth getting right.

About the author: Selwyn
Parker is an author of books on finance and business topics, a specialist in
financial history, and regular contributor to newspapers and magazines. Based in
Spain, France and the UK, he focuses mainly on European developments. His latest
book, The Great Crash, is a new history of the Great Depression that among other
things explains the rise of regulation in the form of the SEC and related
authorities. Selwyn is a regular contributor to Wolters Kluwer Compliance
Resource Network.

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